Here, Eagan talks about late expansion phase dynamics and how he and team members are leaning in on credit risk and away from interest rate risks.
First off Matt, how would you describe the market environment?
It has been kind of a dogfight. We’re seeing quite a bit of angst about where the Fed is in its normalizing process. The US economy appears strong, with data for both manufacturing and non-manufacturing very solid. But the Fed activity has had a dampening effect on global growth, which is concerning. We are seeing pricing and valuation adjustments take place. Then there are some risks that could derail things – such as geopolitics and trade tensions. Overall, I do believe we can still generate an attractive yield in this environment. It is important to remain focused on a risk-reward profile right now. Duration decisions we have to make going forward will be very important.
What are your views on interest rates and Fed policy?
I think we're entering a more high-stakes phase of the Fed cycle because it’s now in the so-called neutral-rate policy phase. The Fed will probably lean toward being somewhat careful about not going too tight prematurely. That means as inflation lifts, they will lift rates hoping to stay right in that neutral-rate area. That's a very Goldilocks scenario and it would be a really big win for the Fed if they could do it.
In the US, inflation is a bit less than the Fed's target of 2.0%. While inflation decelerated somewhat through December 2018, we expect there will be a resumption of upward momentum in 2019, partially due to US unemployment being at its lowest level in decades. The Fed raised interest rates at its December meeting. In our view there is a good probability of additional hikes next year as well, pushing the Fed Funds rate towards 3.0% while the 10-year US Treasury yield moves beyond 3.0% over the next year or two.
How are these dynamics influencing portfolio management decisions?
We think it makes sense to lean in on credit risk and away from interest rate risk. I would rather be short on duration and wrong than long and wrong given low rates and increasing Fed rates. Within credit, we can really rely on Loomis Sayles’ deep credit research capabilities to selectively reach for yield.
But I do think as the rates rise more, a big decision we have to make in the not-so-distant future will be when to increase that duration. Also, treading cautiously in EM is usually the right prescription when the Fed is raising rates.
Why might Loomis Sayles Research be more important than ever?
At this point in the cycle, security selection becomes even more critical for generating alpha because credit spreads are tight and yields are low. Integrated bottom-up research provides us with the confidence we need to take prudent risk and be patient, value-oriented investors.
Can you provide an example of being patient and taking advantage of what the market presents?
Going back to 2015, we held a variety of investments in the energy sector, including investment grade, convertibles, high yield and bank loans. When bond prices fell, the risk analysis done on certain potential investments dictated that the reward-to-risk trade-off of entering these positions was actually very healthy. So we patiently took on these positions, accepting some drawdown at the onset. When oil prices rebounded, and the market reset itself, we were nicely rewarded.
Where are you finding value today?
We think one of the more favorable places to invest is US high yield. Though the pace of growth is slowing, the economy is doing well, corporate profits are strong, credit fundamentals are solid, and we think default rates are going to remain very subdued over the next couple of years. With durations on the shorter end of the spectrum, this asset class is less sensitive to upward pressure on rates. We also see selected value opportunities in convertible bonds.
You are on both the Strategic Alpha and Multisector Full Discretion teams. What’s behind each approach?
Both have flexible frameworks to pursue opportunities across global markets and pivot away from perceived risks. They are benchmark agnostic and can work as diversifiers to traditional bond portfolios. In comparison, Strategic Alpha is really an all-weather strategy designed to provide consistent results throughout the cycle. It has the ability to go long or short and use non-traditional tools to dampen volatility. Our Multisector Full Discretion strategies take an opportunistic, go-anywhere approach, identifying undervalued bonds with favorable current yield and strong prospects for price appreciation.
Overall, both strategies emphasize investments with strong underlying fundamentals and yield advantage. With the security selection expertise we have at Loomis Sayles, we believe we are well positioned to deliver on that.
Diversification does not guarantee a profit or protect against a loss.
All investing involves risk, including the risk of loss.
Alpha is a measure of the difference between a portfolio's actual returns and its expected performance, given its level of systematic market risk. A positive alpha indicates outperformance and negative alpha indicates underperformance relative to the portfolio's level of systematic risk..
Natixis Distribution, L.P. is a limited purpose broker-dealer and the distributor of various registered investment companies for which advisory services are provided by affiliates of Natixis Investment Managers. Natixis Distribution, L.P. is located at 888 Boylston Street, Suite 800, Boston, MA 02199. • 800-862-4863 • im.natixis.com